Sterling bounces back as Draghi's caution knocks Euro

Tom Tong11/Feb/2013Currency Updates

The star in FX markets last week was sterling, which sharply reversed its trend of the past few weeks and bounced back strongly against nearly all major currencies. In general last week saw a partial reversal of the trends that have been in place since the beginning of 2013. The euro gave back about half its gains, and the yen and Swiss franc recovered about a quarter of their losses.

The moves in sterling and euro were mostly driven by their respective Central Banks. Carney sounded more hawkish and Draghi more cautious in their respective monthly meetings than the market had been expecting. It is clear, however, that investors are not yet focusing in the macroeconomic fundamentals of each area, since the euro remains comfortably above the 1.33 mark against the dollar.

GBP

The MPC of the Bank of England decided to keep policy on hold last week, as widely expected. More interesting was the appearance of the Bank of England heir apparent, current Bank of Canada Governor Carney before the Treasury Select committee. He appeared to back away from the idea that nominal GDP targeting should replace the current inflation targeting framework. Since the former would call for more aggressive monetary easing than the latter, the market rightly interpreted these remarks as hawkish, and sent sterling sharply higher against most major currencies.

Macroecoomic figures were somewhat positive in the UK last week, but they were ignored by FX markets, which continue to be focused almost exclusively in the relative dovishness of each currency monetary authorities. The services PMI business rebounded by 2.6 points, crossing back across the 50 level that signifies growth and generating some optimism that growth will return to the British economy in the first quarter of 2013.

EUR

There were some moderately positive macroeconomic news out of Germany last week, but markets chose to ignore it and focus squarely on the relatively downbeat and cautious assessment given by Draghi at last week’s policy meeting.

The ECB head issued a downbeat report on the prospects for the eurozone, and expressed concerns with the effects of the strong euro and excessive repayment of the LTRO funding facility and their impact on financial conditions. Critically, he mentioned that the ECB staff will include the stronger euro in their growth and inflation forecasts, which we interpret as a broad hint that a cut may be back on the table.

Markets lost no time in knocking the euro for a loop, and the common currency had its worst week in along time, losing 1.5% against the dollar and 2.5% against sterling.

USD

A spate of second-tier macroeconomic reports in the US last week did bring some reassurance that economic growth is set to bounce back in the current quarter. In addition to the expected upward impact from the bounce back in inventory levels, the December trade report came out considerably better than expected. Merchandise exports expanded by 2.6% for the month, even as imports contracted by 3.1%. The external sector is set to buoy growth in the current quarter, as opposed to the drag it caused in the last quarter.

Overall we are still comfortable with our forecast for 2.5% GDP growth in the first quarter of this year, as long as the upcoming “sequester” fight does not get out of hand and results in excessive Federal expenditure cuts.

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Written by Tom Tong

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